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As Tariff-Driven Inflation Cools, the Fed's Hawkish Bias Wavers

By ariachiang

2026-08-13

For much of this year, the market's central anxiety was not when the Federal Reserve would start cutting rates, but whether tariff pass-through would force the central bank back into a hiking cycle. That worry built steadily in the first half of the year as tariff costs worked their way into consumer prices and raw material costs climbed. The latest U.S. July CPI report showed both headline and core inflation decelerating from the prior month, with core price growth cooling back to the same level last seen in January and February this year. The conversation has now shifted from whether the Fed will hike again to how long this pause can hold, and that pivot is the structural signal worth watching most closely right now.

The main forces behind this cooling are continued easing in energy price pressure and a broad market view that most of the tariff cost pass-through into consumer prices has already worked its way into the data, while a modest year-over-year decline in real average hourly earnings in July has cooled consumer momentum and further undercut the case for renewed tightening. Yet the cooling is not uniform: prices for computer software and peripheral equipment rose more than a fifth from a year earlier to a record high, reflecting upstream cost pressure from AI data centers scrambling for memory chips, a reminder that tech-related goods remain a corner the tariff relief story has yet to reach. The Fed itself is showing internal division, with some officials at last month's meeting already arguing for a hike, and a September decision that falls awkwardly close to the sensitive window around the year's midterm elections is pushing policymakers toward a more cautious pace. Whether the inflation risk has truly passed remains a genuine point of disagreement in the market.

Looking one to three months ahead, a September hold remains the dominant market expectation, and hawkish bets have eased only modestly from where they stood before the data, meaning most traders are still pricing in some risk of a policy path skewing slightly hawkish. If the labor market keeps softening and consumer momentum stays weak over the next six to twelve months, the doves could gain further ground, opening the door to a policy pivot next year. This is not an all-clear signal, however: Washington's recent reliance on drawing down oil inventories to cushion price spikes is not a sustainable fix, and any renewed climb in oil prices could reaccelerate energy inflation later this year, giving the hawkish narrative room to resurface.

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